RESEARCH NOTE. Qantas Group Ltd Neutral

Transcription

1 1 RESEARCH NOTE Qantas Group Ltd Neutral Price: A$5.80 Price Target: A$6.17 ASX: QAN 18 September 2017 Myer Holdings (MYR) reported disappointing FY17 results and guided to a weak start to the FY18 year, as management expects a -2.8% decline in FY18 underlying earnings (NPAT) (on our calcs) to FY17. Whilst we see current valuation as undemanding and believe Premier Investment s stake of 10.77% in MYR will likely keep the talk of potential takeover surrounding the stock, we see no reason for new investors to consider MYR for the time being and see the stock trade in a range. For current shareholders, we would not oppose a sell down and see (1) better allocation of capital elsewhere; and (2) no significant improvement to fundamentals of the stock and downside risk to earnings on poor retail sales environment (as per management s guidance). We downgrade to Sell. Management s FY18 Outlook. Management expects in 1H18, Group Capacity to increase by ~+3%, with domestic capacity decreasing -1% and international capacity increasing by ~+5% (on new routes into Asia). Competitor capacity growth is expected to slow to ~4%. Net capital expenditure is expected to be $3.0bn for FY18 and FY19 combined. Inflation of expenditures is expected to be $250m. FY18 fuel cost expected to be flat over FY17. On the analyst call, management noted they expect lower fuel costs in FY18, stating due to the hedging we have in place, our worst-case financial 2018 fuel bill is expected to be no more than $3.16bn and is estimated to be $3.11bn, at current forward AUD prices. The worst-case fuel position for the first half of the financial year 2018 is $1.56bn.

2 2 Transformation targets reaffirmed. QAN reaffirmed its ongoing transformation target set at the Investor Day in May, to deliver gross benefits of $400m per year for financial years 2018 to Strong capital position + share buyback should support share price. QAN s balance sheet was significantly stronger than the prior year with net debt at $5.2bn, towards the lower end of QAN s target range. Considering the strength of the balance sheet and the outlook, QAN s board declared $0.07 per share interim dividend unfranked, and an on-market share buyback of up to $373m, taking the total capital return to shareholders up to $500m for the half. Qantas Domestic was the highlight (35.1% revenue, 40.6% underlying EBIT). Underlying EBIT of $645m, rose +11.6% as a focus on costs increased margins from 10.1% to 11.5% despite revenues falling -1.4% (on declining travel from the resource sector). On the analyst call, management called out we saw the continuation of a stable competitive environment. Market demand increased 1.1% despite the resource sector in decline. Demand from the business market across both corporate and SME strengthened in the second half and healthy demand was observed in price-driven segments. East Coast routes have continued to experience strong demand from both business and leisure customers. Jetstar Group (22.4% revenue, 26.2% underlying EBIT). Revenue fell -1.0% over the pcp, underlying EBIT of $417m fell -7.7% over the pcp, and margins declined from 12.4% to 11.6%. This was due to the impact of booking and service fee changes and lower freight yields. Management expects to increase capacity by +3% from cabin upgrades to the airline s A320s during FY18. The airline will start a new route from Melbourne to the Central Chinese city of Zhengzhou from December Qantas International drove results weaker (35.5% revenue, 20.6% underlying EBIT). Qantas International reported underlying EBIT of $327m, fell -36.1% over the pcp, on pressure from competition which increased capacity by +8.5% in the broader market (driving a -6.5% decline in unit revenue). Relative to competitors, QAN was able to maintain a 5.7% margin. On the analyst call, management pointed out international markets saw 11% capacity added in the first half. However, this moderated to 5% during the second half, providing some relief from the competitive pressures on

3 3 airfares demand continues to grow in Asia markets for both premium and leisure customers. Investment Thesis We rate QAN as a Neutral and believe the following drivers of performance in will see the stock outperform the market: All segments delivering return on invested capital > weighted average cost of capital. Strong position in domestic market (Qantas Domestic and Jetstar continue to remain the two highest margin earning airlines in the domestic market). Jetstar is well positioned for growth and rising demand in Asia. Partnership with Woolworths for Loyalty bodes well for membership and earnings. Oil prices expected to be fairly stable. Increased competition in international is affecting that segment. Relative to peers, strong balance sheet strength; investment grade credit rating. Key Risks We see the following key risks to our investment thesis: Disasters that could hurt the QAN brand. Ongoing price led competition forcing QAN to cut prices affecting margins. Leveraged to the price of oil. Adverse currency movements results in less travel. Labour strikes.

4 4 Depressed economic conditions leading to less discretionary income to spend on travel. Company Description Qantas Airways Ltd (QAN) provides passenger and freight air transportation services in Australia and internationally. QAN also operates frequent flyer loyalty program. QAN was founded in 1920 and is headquartered in Mascot, Australia. FIGURE 1: REVENUE CONTRIBUTION BY SEGMENT

5 5 FIGURE 2: EBIT CONTRIBUTION BY SEGMENT QAN s FY17 Results Summary FIGURE 3: FY17 RESULTS From FY16 to FY17. The bridge from FY16 to FY17 result consists of the following components: (1) Net passenger revenue was

6 6 down $104m as competitive pressures in international markets and the continued decline in resources revenue outweighed the benefits from capacity adjustments and transformation of $135m. (2) Fuel expense was $196m lower, including $35m of benefits from transformation, with a disciplined hedging program continuing to allow QAN to participate in lower fuel prices. (3) Increased activity and network changes cost $129m as group capacity grew by 1.1%. (4) Transformation delivered ex-fuel cost reduction of $300m, more than offsetting the impact of inflation. (5) Depreciation and rentals rose $53m, driven primarily by investment in fleet reconfiguration programs, software and capitalized maintenance. (6) Earnings contribution from QAN s freight business fell $42m due to competitive pressures in international freight markets. Fleet upgrades. During the year, QAN added three Fokker F100 aircraft to reduce capacity but maintain frequency on resources routes. Jetstar added two Airbus A321 aircraft to meet demand in short-haul leisure markets. By 1H19, QAN plans to replace five old jumbo jets with eight new Dreamliner 787-9s, with two jumbos due to be retired in FY18. New flight routes. As previously announced, QAN will begin direct flights from Perth to London next year. QAN is also exploring the possibility of direct flights from the east coast of Australia to London and New York by 2022, with QAN requesting Boeing and Airbus to build an aircraft to achieve this aim. Fuel and hedging. On QAN s hedging program, management highlighted, is designed to protect the group from material adverse fluctuations in fuel and foreign exchange, whilst importantly allowing for participation to favorable movements. We have a high level of protection in place for FY18. The group's Aussie dollar fuel risk is 86% hedged. We expect the group's full year cost to be $3.11bn based on the forward Aussie dollar fuel curve and no worse than $3.16bn. This, importantly again, is inclusive of all option premium. We maintain a higher proportion of options providing 50% participation to lower Aussie dollar Brent prices in financial year 2018 should prices fall from here.

7 7 FIGURE 4: PROFIT BRIDGE UNDERLYING PROFIT BEFORE TAX Segment Results Qantas Domestic was the highlight (35.1% of revenue, 40.6% of underlying EBIT). Underlying EBIT of $645m, rose +11.6% as a focus on costs increased margins from 10.1% to 11.5% despite revenues falling -1.4% (on declining travel from the resource sector). On the analyst call, management called out we saw the continuation of a stable competitive environment. Market demand increased 1.1% despite the resource sector in decline. Demand from the business market across both corporate and SME strengthened in the second half and healthy demand was observed in price-driven segments. East Coast routes have continued to experience strong demand from both business and leisure customers. Jetstar Group (22.4% of revenue, 26.2% of underlying EBIT). Revenue fell -1.0% over the pcp, underlying EBIT of $417m fell - 7.7% over the pcp, and margins declined from 12.4% to 11.6%. This was due to the impact of booking and service fee changes and lower freight yields. Management expects to increase capacity by +3% from cabin upgrades to the airline s A320s during FY18. The airline will start a new route from Melbourne to the Central Chinese city of Zhengzhou from December Qantas International drove results weaker (35.5% of revenue, 20.6% of underlying EBIT). Qantas International reported underlying EBIT of $327m, fell -36.1% over the pcp, on pressure from competition which increased capacity by +8.5% in the broader market (driving a -6.5% decline in unit revenue). Relative to competitors, QAN was able to maintain a 5.7% margin. On the analyst call, management pointed out international markets saw 11% capacity added in the first half. However, this moderated to 5% during the second half, providing some relief from the

8 8 competitive pressures on airfares demand continues to grow in Asia markets for both premium and leisure customers. Qantas Loyalty continues stable growth (9.4% of revenue, 23.2% of underlying EBIT). Over the pcp, revenue rose +3.5% and EBIT rose +6.6%, driven by the increased number of Qantas Frequent Flyer members (up +3.5%). The results were driven by more Woolworths customers preferring to earn Qantas Points and 22 new program partners. CEO Alan Joyce said Qantas Loyalty continues to participate in market disruption, via Qantas Assure and Qantas Money as the financial services sector faces changing market conditions due to the new interchange fee regulations. The Frequent Flyer points and earning potential in this environment remains strong due to the increasing trend towards transactions made on cards. Qantas Freight struggles in a challenging environment (5.8% of revenue, 3.0% of underlying EBIT). Over the pcp, revenue was down -4.5% and EBIT of $47m, was down -26.6% driven by softer demand and competition in international freight. Qantas continues to retain its domestic freight market share. FIGURE 5: QANTAS DOMESTIC FIGURE 6: JETSTAR GROUP FIGURE 7: QANTAS INTERNATIONAL

9 9 FIGURE 8: QANTAS LOYALTY FIGURE 9: QANTAS FREIGHT FIGURE 10: QAN FINANCIAL SUMMARY Disclaimer/Disclosure

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